Tag Archives for prices

Water prices in the southern Murray-Darling Basin have reached their highest levels since the worst of the Millennium drought more than a decade ago. These high water prices are causing much anxiety in the region, and have led the federal government to call on the Australian Competition and Consumer Commission to hold an inquiry into the water market.

While some of these factors have had an effect on the market, they are in many ways a distraction from the simpler truth: that high water prices have mostly been caused by a lack of rain.

Supply drives the market

The waters of the northern basin run to the Darling River and the waters of the southern basin run to the Murray River.MDBA

Market reforms in the 1980s and 1990s enabled water trading in many parts of Australia. By far the most active market exists in the southern Murray-Darling basin, which covers the Murray River and its tributaries in northern Victoria, southern New South Wales and eastern South Australia.

The market allows users – mostly irrigation farmers – to trade their water allocations (effectively shares of water in the rivers’ major dams). This trading helps ensure limited water supplies go to the farmers who value them the most, which can be crucial in times of drought.

The following chart shows storage volumes (in orange) and water prices (in red) in the southern basin since 2006. Prices peaked at the height of the Millennium drought in 2007. During the floods of 2011, they fell near zero. Prices have increased again during the latest drought, and are now at their highest levels in a decade.

Lower rainfall, higher temperatures

While water prices have always been higher in dry years and lower in wet, we’ve been getting a lot more dry years in recent decades.

Over the past 20 years, rainfall, run-off and stream flow in the southern basin has been far less than historical conditions.

The below chart shows modelled flow data for the Murray River, assuming historical weather conditions and no water extraction, over the past century. It shows that average water flows this century are about 40% below the average of the 20th century.

Lower rainfall and higher temperatures also make crops thirstier, increasing demand for irrigation water. This was evident in January, when temperatures exceeded 35℃ for 14 days and irrigators’ demand for water spiked from about 4.5 gigalitres to 7 gigalitres a day.

The basin plan in perspective

The Murray-Darling Basin Plan seeks to improve the environmental health of the river system by recovering water rights from irrigation farmers. To date, more than 1,700 gigalitres of water rights – about 20% of annual water supply – have been recovered in the southern basin.

By reducing supply, water recovery was always expected to increase water prices. However, the effects of water recovery on supply – while significant – are still small relative to the effects of climate over the same period, as shown in the below chart.

Water allocation use in the southern basin with and without water recovery.State government agencies, Department of Agriculture, ABARES estimates.

Measuring the precise effect of water recovery on prices is difficult. Water buybacks are straightforward and have been modelled by ABARES and others. But the effects of infrastructure programs – where farmers return a portion of their water rights in exchange for funding to upgrade infrastructure – are harder to estimate.

‘Carryover’ rule changes

Historically farmers had to use water allocations within a 12-month window. The introduction of “carryover” – most recently in Victoria in 2008 – means users can now hold their unused water in dams. This rule change was a good thing, as it encourages farmers to conserve water and build up a buffer against drought.

But it might also have contributed to anxiety about the water market’s operations.

Since water allocations can be bought and held for multiple years, information about future conditions can have a big effect on prices now. For example, we see large jumps in price following news of worse-than-expected supply forecasts. This may have helped fuel concern about “speculators”.

Over the longer-term, the ability to store water helps to “smooth” water prices, with slightly higher prices in most years offset by much lower prices in drought years. Again this is a good thing, but it may have added to the perception of higher prices in the market.

Water demand is rising

When a profitable new irrigation activity is willing to pay more for water – as is the case with almond farms in the southern basin – competition for limited supplies can potentially drive up prices.

ABARES’ research shows that between 2003 and 2016 there was little change in irrigation demand (aside from that linked to rainfall). Growth in demand from expanding activities such as almonds and cotton was offset by reductions in others including dairy, rice and wine grapes. However, there is evidence since 2016 that demand for water has started to increase, contributing to higher water prices. Longer-term projections suggest this trend may continue.

With drought and climate change reducing water supply, and demand for both environmental and irrigation water increasing, high water prices are only likely to become more common in the basin in future.

Fresh focus will turn to the energy debate this week, with a Fairfax
Ipsos poll showing 47% of Australians support giving the main priority
to cutting bills, and Labor expected to release details of its energy
policy.

The Ipsos poll found 39% want the federal government to give the main
priority to reducing carbon emissions, while 13% were most concerned
with reducing the risk of blackouts.

In a highly interventionist approach, the government is concentrating
on wielding what it calls “a big stick” to force power companies to
lower prices.

Ipsos found a big difference in priorities according to which party
people supported. Among Coalition voters, 58% prioritised reducing
bills, compared with 22% who nominated cutting emissions and 20% who
opted for reducing the risk of blackouts.

But a majority of Labor voters put reducing emissions top (53%), with
36% opting for giving priority to cutting power prices and only 11%
nominating reducing the blackout risk. Three quarters of Greens voters
gave top priority to cutting emissions.

Voters outside capital cities are more likely to give priority to
cutting bills than urban voters. People aged 40-54 are more likely
than other age groups to be concerned with reducing bills, as are
those on incomes under $100,000 compared with people with higher
income.

Younger voters are more likely to give priority to cutting emissions
than older age groups.

The Ipsos poll has Labor leading in two-party terms 52-48%.

Bill Shorten on Thursday addresses BloombergNEF with a speech billed
“Labor’s plan to tackle Australia’s energy crisis”. The address will
be followed by a question and answer session.

Labor’s shadow cabinet will consider the ALP policy before the speech.

Labor has previously flagged it is open to incorporating aspects of
the National Energy Guarantee that the Coalition abandoned in its
internal meltdown that ended in the change of leadership.

Fairfax Media reported at the weekend that Labor’s policy “is modelled
on the guarantee, but the party is also working towards a much broader
set of measures as it seeks to compete with the government’s pledge to
bring down power prices and shore up supplies.”

The ALP is committed to cutting emissions by 45% by 2030 off a 2005 baseline.

The keenly awaited report on retail electricity prices, released this week by the Australian Competition and Consumer Commission (ACCC), has made some controversial recommendations – not least the call to wind up the scheme that offers incentives for household solar nearly ten years early.

The report recommends that the small-scale renewable energy scheme (SRES) should be abolished by 2021. It also calls on state governments to fund solar feed-in tariffs through their budgets, rather than through consumers’ energy bills.

The ACCC has concluded that offering subsidies for household solar was a well-intentioned but ultimately misguided policy. Solar schemes were too generous, unfairly disadvantaged lower-income households, and failed to adjust to the changing economics of household solar.

The lesson for policy-makers is that good policy must keep costs down as Australia navigates the transition to a low-emissions economy in the future. Failure to do this risks losing the support of consumers and voters.

Runaway rebates

Rooftop solar schemes were much more popular than anticipated. This might sound like the sign of a good policy. But in reality it was more like designing a car with an accelerator but no brakes.

Generous feed-in tariffs and falling small-scale solar installation costs encouraged more households to install solar than were initially expected. Premium feed-in tariffs were well above what generators were paid for their electricity production. Historically solar feed-in tariffs paid households were between 16c and 60c per kilowatt-hour, while wholesale prices were less than 5c per kWh.

At the same time, installation costs for solar panels fell from around A$18,000 for a 1.5kW system in 2007, to around A$5,000 for a 3kW system today. The SRES subsidy for solar installations was not linked to the actual installation cost or the cost above the break-even price. So the SRES became relatively more generous as installation costs fell.

As solar penetration increased, and network costs rose to cover this, it became increasingly attractive for households to install solar panels. In Queensland, the initial cost forecast for the solar bonus scheme was A$15 million. Actual payments were more than 20 times that in 2014-15, at A$319 million. And the environmental benefits weren’t big enough to justify that cost, as other policies have reduced emissions at a lower cost. The large-scale renewable energy target reduced emissions for A$32 per tonne, while household solar panels reduced emissions at a cost of more than A$175 per tonne.

In most states, premium feed-in tariffs and rooftop solar subsidies are funded through higher bills for all consumers. Everyone pays the costs, yet only those with panels receive the benefits. That means the costs fall disproportionately on lower-income households and those who rent rather than own their home.

The ACCC report recommends the SRES be wound up nearly 10 years ahead of schedule, because the subsidies are no longer financially justifiable. This would maintain the support for current solar installations but remove subsidies for new solar installations from 2021.

The report also recommends removing the direct costs of feed-in tariffs from electricity bills. Instead, state governments should directly cover the costs of premium feed-in tariffs. The Queensland government has already made this move.

Of course, governments still have to find the money from elsewhere in their revenues, which means taxpayers are still footing the bill. But the new arrangement would at least remove the current unfair burden on households without solar.

Fixing the mistakes

How can governments avoid making similar policy mistakes in the future? The ACCC’s recommendations, together with the proposed National Energy Guarantee (NEG), provide a solid foundation for Australia’s future energy policy.

First, the future is hard to predict, so good policy adapts to change. The NEG provides a flexible framework to direct energy policy towards a low-emission, high-reliability, low-cost future. Reviewing and adjusting the emissions target along the way will enable Australia’s energy policy to respond to new technologies and shifting cost structures, while maintaining consistency with economy-wide targets.

Second, it is hard to pick winners, so good policy creates clear market signals. The NEG provides the energy industry with clear expectations, but is technology-agnostic and minimises government intervention. This encourages the market to find the most cost-effective way to reduce emissions and ensure reliability.

The ACCC report also recommends simplifying retail electricity offers, which would make it easier for consumers to find a good deal, and in turn making the market more competitive.

Politicians have an opportunity to draw a line in the sand on narrow, technology-specific policies such the SRES. An integrated energy and climate policy should focus on good design, and then step back and let the market pick the winners.

The centrepiece of the Coalition’s climate policy, meanwhile, is the A$2.5 billion Emissions Reduction Fund. An important element of this scheme is the “safeguard mechanism”, which is due to kick in on July 1 this year. This has implications for the electricity sector and may also affect electricity prices.

These policies will affect the wholesale electricity market, in which electricity is bought from power generators and sold on to retailers and consumers.

As you can see from the figure to the right, the competitive component of the retail prices makes up about 50% of the typical household electricity bill, and the wholesale component typically makes up half of that. The other major cost is poles and wires.

So how exactly will the different climate policies affect electricity prices?

The safeguard mechanism (Coalition)

The safeguard mechanism will require Australia’s largest emitters to keep emissions below a baseline. This will prevent emissions reductions under the ERF being offset by increases elsewhere. Businesses that go over the baseline will have to pay.

The safeguard is based on the high point in annual emissions from the whole electricity sector between 2009-10 and 2013-14. Generators’ individual baselines and associated penalties only come into play if the whole sector goes over the baseline.

As you can see in the figure below, emissions have fallen by almost 20 million tonnes per year since the first baseline year (2009-10), partially in response to years of declining demand.

Current projections for electricity growth suggest that the baseline won’t be breached for some years. As such, individual generators are unlikely to be penalised, and wholesale prices would not be expected to change dramatically.

This also places a baseline on the electricity sector, but it is calculated on the basis of emissions intensity (tonnes of emissions per unit of electricity generated) rather than overall emissions. Generators with emissions intensity below the baseline (for example, gas generators) would earn credit, so “cleaner” power plants would generate more credits.

Power plants that go over the baseline (for example, brown coal) would have to buy credits for the amount they go over. “Dirtier” plants would thus have to buy more credits.

This is substantially different to a carbon tax or the previous emissions trading scheme. Under these policies, all generators are penalised, some more than others, as you can see in the figure below.

Impact of carbon price and baseline and credit scheme on different generation technology in the electricity sector. A carbon prices increases all prices, relative to emissions intensity. A baseline and credit scheme increases the price of high-emissions-intensity generation, but lowers the price of low-emissions-intensity generation.Author

This difference is important for electricity prices. Dirtier plants would be expected to increase their selling price to cover the financial penalty on their emissions. But cleaner plants, earning revenue from selling credits, could afford to sell their electricity more cheaply.

This is important, because cleaner plants (typically black coal or gas) set the price. Gas in particular would probably be significantly cheaper under this proposal. As such, the impact on wholesale prices would be small, or negative.

In fact, as the AEMC itself noted, the impact on the wholesale market could be an increase or decrease in prices (depending on where the baseline is set).

The brown coal exit (Labor)

Another component of Labor’s climate platform is a plan to finance the closure of brown coal power stations, an idea first proposed by ANU climate economists Frank Jotzo and Salim Mazouz.

In this proposal, brown coal plants would bid for the payment they would require to finance their own shutdown, with the cheapest bid being selected. The remaining plants would pay this cost, in line with their emissions.

Similar to the ETS, it would be expected that this cost would be reflected in increased offer prices to the market from the remaining generators. The direct costs would be temporary (a one-off payment) and small, relative to the overall wholesale price.

Indeed, Jotzo and Mazouz estimated it could cause a one-off rise of 1-2% in retail power bills. Analysis company Reputex found the impact could be between 0.2% and 1.3%.

However, Danny Price of Frontier Economics has suggested that the scheme could push up retail power prices by between 8% and 25%, as the result of a short-term price shock. But given the significant excess capacity in the market, and assuming that the market is indeed competitive, it is hard to see how such a increase would happen.

This point aside, the price argument misses the point of the scheme, which aims to deliver an “orderly transition” away from brown coal. The longer-term effects on supply and price of a brown coal exit will be similar, regardless of how the industry closes.

In fact, if it were left entirely to the market, the sudden retirement of an entire power plant might create even more of shock. This proposal is chiefly about ensuring an orderly, predictable transition.

50% renewable energy target (Labor)

The final element of Labor’s climate platform is a 50% renewable energy target by 2030. At this stage, not much detail has been unveiled other than shadow environment minister Mark Butler’s pledge that it will be “designed in a way that does not disturb investor sentiment around the delivery of the existing Renewable Energy Target” – something that a sector beset by uncertainty would welcome. As such, it is quite difficult to speculate on how electricity prices might react.

The current Renewable Energy Target is a certificate scheme that requires retailers to buy a certain amount of renewable energy. The cost of these certificates is passed on through electricity bills. However, as shown by the government’s own modelling, the interaction with the wholesale market results in a net saving to consumers.

Interestingly, and as the AEMC points out, the electricity ETS is designed to be flexible and integrate with a renewable energy target. Indeed, such an ETS could drive investment in renewable energy, replacing current subsidies through the Renewable Energy Target. The 50% target could theoretically be achieved through the ETS alone, if the baseline was set at the right level.

A bipartisan approach?

As it stands, the government’s climate platform is unlikely to have any impact on electricity prices. However, it will also not have a major impact on the electricity sector’s emissions.

Labor’s policies will have an impact, but as the AEMC notes it may occur “without a significant effect on absolute price levels faced by consumers”.

The government’s current polices will require strengthening to further reduce emissions. To achieve this, the Grattan Institute and others including the Business Council of Australia have supported ideas that would turn the Liberal platform into something very similar to Labor’s.

Indeed, modelling commissioned by the government itself assumes that Direct Action will eventually morph into a similar baseline-and-credit ETS, in order to meet long-term climate commitments.

Political slogans aside, perhaps a bipartisan approach is possible, without a significant effect on power bills.

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